World View & Market Commentary. Forest first; Trees second. Focused on Real & Knowable facts that filter through the "experts" fluff and media hyperbole. Where we've been, what the future may hold and developing a better way forward.

Monday, October 26, 2009

With a record $123 billion in bond (debt) issuance just this week ($6.4 trillion annualized), rates are breaking major trendlines on the longer end of the debt yield curve.

The pundits in the media and the analysts who work for the investment brokerages, who have their product to sell, are telling people that this is occurring due to the strength in the economy. Nothing could be further from the truth. Rates go higher when risk goes higher, and the risk for holders of debt are becoming extreme.

The Fed has been artificially keeping rates low via buying up their own debt issuance, in effect monetizing our debts. That is obviously not sustainable. Rates moving higher off a zero interest rate policy is certainly not unexpected. However, with debt saturation permeating our economy and government, higher rates means nothing but DRAG on the economy. The higher the rates, the higher the drag.

I have repeatedly showed the pattern playing out in TLT, the 20 year bond fund (Bond Market Hide & Seek – A Domed House & 3 Peaks...). Now that pattern appears to be headed for the next leg down as the sideways consolidation over the past 4 months is breaking the lower trend line. The target on that break is substantially lower, meaning interest rates substantially higher. Below is a 2 year chart of TLT:

Below that is a 6 month chart of TLT. As it broke that red rising trend line I wrote an update advising that a break of the lower trendline would signal the beginning of the next significant move – here we are:

The long bond futures, /ZB, show this breakdown even more clearly:

In the 3 year chart of USB below, the 30 year bond fund, you can see that bond prices are already substantially off their highs. That pattern is a clear Head & Shoulders pattern with the neckline in the 115 area and the right shoulder forming now. Should prices break below that neckline, the target is OMINOUS, down in the mid 80’s. That would spell much higher rates for debt and huge losses for bond prices.

TNX, the 10 year treasury note RATE, is also producing a pattern that is indicative of higher rates ahead. It recently broke a smaller triangle and is heading up to an inverted H&S neckline that is in the 4% area. Should that pattern break the neckline upwards, it is targeting roughly 6% for the 10 year note. While that may not sound ominous, keep in mind the levels of debt in our economy.

Now, let’s zoom out and look at the past 20 years in the TNX. Here you will see the very clear downtrend line that has followed the historic 30 year decline in rates from the peak in 1980 until Ben Bernanke forced them to zero last year. If that inverted H&S pattern target area of 6% is achieved, you can see that the 30 year downtrend line will be clearly shattered. Keep in mind that that pattern is NOT confirmed until the neckline is broken. Like I’ve been saying, we are entering a new era… when rates were falling, it was favorable to debt – the era of leverage. Once that trend reverses, debt is no longer your friend, it is your enemy as rates go higher. Those who recognize this trend change too late are going to make huge mistakes.

Remember that bond holders are generally more savvy than equity investors. They know that higher rates are coming and they know that owning bonds while rates are rising is a huge mistake. The government, through their Primary Dealers, and through the Primary Dealer’s surrogates, are buying the debt to keep our national debts financed. That Ponzi scheme is going to end, and when it does it’s going to end very badly.

Money, capital, does flow like water from one investment to the next. There’s enough water in the system to drown, no doubt. The question is, where will the capital flow? Into equities? Maybe for awhile, but higher rates will make it painfully clear that companies who hold debt will have a difficult future ahead - that would be most companies. Capital does not have to stay in the U.S., either. It can, and will, flow overseas. Anyplace where it is treated better, and it will be treated better by any country that follows the rule of law and is not as debt saturated as we are.

And by the way… I’ve seen rebuttals to this argument stating that our debt is “only” 40% of GDP and therefore not yet a serious problem. To those who believe that, you need to wake the heck up! In the first place, our GDP is trumped up, it is WAY overestimated. Secondly, our debt is WAY underreported! The true debt to GDP ratio would astonish everyone. Thirdly, debt to GDP is a FALSE FLAG measurement. They have NO DIRECT RELATIONSHIP. It is DEBT to INCOME that matters. They can claim all they want that GDP is rising… not only is it NOT RISING, but our nation’s income is CRASHING. Anyone who would like to refute that is welcome to try – in fact, I relish the challenge as this is a MYTH that needs to be buried! Please, oh, please challenge me on that assertion, we will debate it in public as that myth needs to see the light of day! Come prepared with facts, I’ll be bringing charts and a calculator – simple math is all that’s required, and you better know how those statistics are compiled or you will be shredded.

All the little, and not-so-little, white lies compile on one another in distorted statistics that have painted a picture of false health – and even that picture is not that healthy. The bond market is signaling higher rates, the economy will not escape the math of debt, there is no skating away…